Monetary Policy in an Islamic Economy

Dr. M. Vmer Chapra

Monetary policy has to be as important an instrument of public policy in an Islamic economy as it is in its capitalist counterpart. The objectives and tools must, however, be different because of the differences in the goals and the nature of the two systems and because of the prohibition of interest in Islam while it is a key ingredient in the capitalist system. This paper represents an attempt to highlight the role that monetary policy should be designed to play in an Islamic economy and to show how it can be made to play its role effectively if interest is abolished and two important instruments of monetary policy in the capitalist economy, discount rate and open market operations in interest-bearing government securities, are not available. The paper also discusses the mechanism for equating the supply of money with its demand in the absence of interest as a regulating mechanism and the feasible alternative to interest-bearing government securities for financing government budgetary deficits in a non-inflationary framework.